Along with the end of the second quarter earnings season, US stock markets had been positive and placid throughout August. But on Friday, the three US indices plummeted in the worst losses since July's Brexit correction. Rate hike fears were once again the culprit. The environment surrounding a Federal Reserve decision on the federal funds rate is uncertain and induces volatility in securities markets worldwide.
The futures markets place the chance of a September rate hike at about 24% currently, according to the derivatives marketplace CME Group. The argument against a rate hike is strong. The first piece of evidence is the September 2 US jobs report, which was weaker than expected. Nonfarm payrolls rose by 151,000 jobs versus economists' predictions of 180,000. The news gave investors relief, and global stock markets rose on the belief of a lower chance of a September rate hike. Some Wall Street experts agree as well. In a CNBC "Power Lunch" interview, Cowen Group trader David Seaburg stressed that there was zero chance because the Fed would not want to shock investors, saying the odds needed to be at 80% in order for a rate hike to actually happen. Other Wall Street institutions also expect a dovish Fed, with Bank of America (NYSE: BAC) Managing Director Ethan Harris stating that the earliest rate hike would come in December. Finally, history suggests that there will be no rate hike. According to a MarketWatch article, the Fed has a tradition of no surprise rate hikes during election years since 1968. To break with that unstated tradition and cause a market correction ahead of a popular outbound Democratic President would be an anomaly.
On the other hand, there are arguments for a September rate hike. The first is that the Fed must act and cannot delay longer. To prove that the US economy is strong and indeed recovering well, at least one rate hike in 2016 would suffice. The labor market, despite the last jobs report, is firm, with unemployment at 4.9% as of June. Goldman Sachs (NYSE: GS) in particular is standing out, having raised their outlook for a rate hike to 55%, according to Yahoo! Finance's "Goldman Sachs boldly strays from the herd with a contrarian Fed call." The investment bank's chief economist Jan Hatzius believes that growth in nonfarm payrolls was strong enough to hold the unemployment rate steady and cited hawkish statements from Fed Chair Janet Yellen and other officials for support. Finally, a super contrarian view is that the Fed should hike in September to avoid being accused of political partisanship ahead of the election. Otherwise, waiting until December or 2017 might risk overheating the American economy.
It is interesting that Friday was a broad selloff across all sectors. Even financials, which should profit from a rate hike, fell with indices. In light of recent hawkish statements coming from Fed officials like Boston Fed President Eric Rosengren and Richmond Fed President Jeffrey Lacker, the rate hike decision seems more divisive. That translates into more uncertainty and volatility in the stock markets. Investors must be eager to find out on September 21 whose predictions are correct.
The author does not hold any positions in any of the stocks above.